Commercial Property – The Alternative Investment

Commercial Property – the alternative to residential

I have always been surprised by how some people react when I suggest they should investigate commercial property investment because it provides a very a good alternative to residential investment.
It’s “too complicated”, they say. Or “too hard to understand” is another common response, as well as fear of vacancies with a consequent loss of income.
Yes, I agree, residential property is the more “liquid” of the two forms of investment, but successful residential investment is, in my view, the hardest subject to master by far.
We all know the advantages of residential property and they are persuasive, that has to be said, but let me give you some of the disadvantages — so you can judge for yourself.

The main problem with residential is that it’s “political” in every sense of the word. From one day to the next there are continual back ground voices criticising those who own or invest in residential property.
The media run one story after another on overcrowding, shortage of rentals, rising rents, unfair profits, and lately pressure to introduce a capital gains tax or reduce so-called ‘tax rorts’.
It’s no wonder that there is a growing rental crisis, and increasing homelessness, not helped by the recent tax disadvantages which have, as expected, had the exact opposite effect from what was intended.

On the subject of Capital Gains Tax, I have yet to see any hard evidence showing what a capital gains tax would achieve. Yes, it does exist in other countries but such taxes did absolutely nothing to stop runaway property booms (and busts) in the USA, Europe or Australia … just to name a few.
In the news at present time, we learn about the troubles in Spain and Greece where the foreclosures (mortgagee sales in our parlance) are staggering and getting worse by the minute:
see The ghost towns of Spain: Images that are desolate symbols of collapsed property market
Spain already has a capital gains tax. To call it “complex” is a gross understatement
Or how about Greece, where matters are just as bad?  They too have a capital gains tax, but it will likely only create tax credits for years to come. See Greece’s house price falls continue, amidst economic woes.


The call for a Capital Gains Tax in this country are supposedly  to encourage investors to put their spare funds into “more productive investments”. But again, I am still waiting to hear what, exactly, these more productive assets are.
Another problem with residential property as a landlord is the bothersome control over the market by bureaucracy and the well meaning but cumbersome Tenancy Tribunal where all tenancy disputes end up if they cannot be solved by the parties involved.

I would be the first to agree that tenants need some form of protection, and we probably DO need some form of third party control by way of a Tribunal, but the system should allow tenants and landlords to agree to opt out of the system if both parties so choose.
Why should expensive homes, for instance, be subject to government control in regard to bonds or rents? Parties to high end properties hardly need a government watch-dog to breathe down their necks.
And what law applies in the case where a property is rented out fully-furnished as many are? The current bond limitation is totally inadequate to cover damage in this instance.

There’s no doubt that, if done correctly, and with due diligence and forethought, residential investment can be very profitable mainly because it’s (supposedly) understandable, easy to finance with the aid of mortgages, and is happily used by banks as security when advancing other loans … especially for further residential investments or business use.

But there are great advantages for those who make the effort to understand commercial property.



The Upside


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Commercial Property has become even more popular this year and rightly so for the following reasons:

(a) There are fewer controls from any outside body so long as parties act reasonably.
(b) You can charge whatever rent and whatever terms you and your tenant mutually agree upon.
(c )You can ask for any bond you like — again as may be mutually agreed upon.
(d) You can evict bad tenants  more readily under the terms of the lease with little or no outside interference.
(e) The only “control” that exists is the lease that is agreed between you and the tenant (and that can be varied as when it suits).
(f) Depreciation allowances are often higher than on residential especially for fittings and fixtures which tend to be of higher value than residential.
Even more importantly, depending on the lease, your commercial tenant pays for all the out-goings as well, such as rates, water and insurance. Commonly these are spelled out in the lease (i.e. a net lease)  but if not then these costs are built into the rent (i.e. a gross lease).

Either way, the tenant pays … which makes your returns that much better.

A few years ago the traditional return on the average commercial property (whether retail, office or industrial) was around 10%. For example a property valued at $500,000 would pay a net rental of $50,000 per annum after payment of all outgoings.

Over the past few years this return has fallen dramatically, to as low as 5% plus. I suspect it will go even lower for prime properties in the future.
In other words, lower and lower yields means that investors are paying more and more to buy a certain income stream.
In the example above, where the net income is $50,000, investors could now well be prepared to pay almost twice as much as before especially if the property was good. e.g. at a 5.5% yield the same property would be worth over $900,000.

Not a bad return if properly done  - and much easier than trying to extract a profit from of low quality slum properties with  bad tenants.
Recently I had top console a distraught property investor, who had gone to a retirement village and had rented out the family home. The property manager had not done his checks carefully enough and the tenants

used the property as a meths drug factory. So bad was the contamination that the house had to be demolished to ground level, the grounds themselves had to be decontaminated,as well as  the next door neighbors had to have outer walls replaced  so bad was the contamination.
If you intend to remain invested in residential then I strongly recommend that you install monitored drug detectors which act and look like ordinary smoke detectors.

The trick is to find commercial property which can genuinely be “improved” so that is goes up in value … no matter what inflation or deflation are doing.
A little study and perseverance can find these deals and often such value increases can be achieved quite rapidly with little more than a stroke of a pen.
My team and I recently assisted a client into buying a run-down block of shops. With a little expense, and our constant advice we pushed the value up from $1.4 million (being the purchase price) to an estimated value if $2.0 million … and all done within 6 months from date of purchase and while collecting the rent at the same time .
And just to prove the point that it wasn’t just wishful thinking on our part, this particular block was  on- sold at auction for $1.95M which was just a litle under its estimated value.

Recent sales are compelling evidence that prices have moved strongly upwards as compared with the more traditional values of a few years ago . They are a taste of things to come.
If residential sales results showed similar rises in values in today’s financial climate the headlines would be very large and the calls would be coming to introduce new taxes and other ‘disincentives’ (i.e. punishments) for investors who dare make such gains.
Interestingly, the prices obtained are not that far away from those achieved for average “Mum Dad and the three kids” residential properties in the Auckland region  but as the subject is commercial, it has no wide market appeal and it’s therefore not create headlines.
‘Commercial Property Prices Rise Dramatically’ will never be found on page 3 of any newspaper. There are more such deals out there just waiting to be found as many commercial property owners are no fully conversant on how to run a commercial property successfully.
If you are tired of the stress that residential tenants can give — not to mention poor returns, mounting repairs or vexatious complaints — then the commercial property market is just the right place for you.
You could become a part of this very fascinating multi-billion dollar investment niche — an area where big profits can be quietly made providing you know what you are looking for and obtain a good working knowledge in conjunction with impartial advice.


In summary the advantages of commercial property are:
(1) There is little or no corruption and with few exceptions everything is correct and legal.
(2) There is no capital gains tax, no stamp duty, no death duties, no inheritance tax and no land tax. Income tax would apply you were a dealer in commercial property i.e. developing or buying and selling regularly with the intention of making a profit.
(3) Outside of Auckland especially some care has to be taken to ensure that commercial properties have an earthquake rating of 34% of a new property or more. Most builds are well over that figure and the cost to achieve that attain level can be quite low ( heritage and tall buildings may be an exception)
(4)Most commercial leases provide for the tenant to pay the operating expenses such as rates and insurance as well as all internal repairs and maintenance.
(5) Leases on commercial property are often for long periods thereby securing the cash flow. 3-5 years at a time are common but much longer periods are not rare either.
(6) Banks are happy to lend on commercial property but of course they too what to have all the facts especially the leases and the strengths of the tenant or tenants. Most bank will lend up to 65% pf a commercial property’s
registered valuation. I recently secured a multi million commercial loan at 6.01% for 25 years which shows that banks can be just as reasonable with commercial as with residential.
(7) Risk averse investors prefer multi tenanted properties so that the chances of a totally vacant building at any time creates far stress.

To learn more contact me using the contact form here
or phone me direct on 0800  522  622   or 0274 928 460 and my team and I will be only to happy to help.

Posted in News & Articles | 1 Reply

One thought on “Commercial Property – The Alternative Investment

  1. You’re short on info on points 4, 5 and 6 and generally wrong.

    Point 7 needs considerable work. For one, I wouldn’t view risk as a investment criteria but investor type as a category in itself as to ‘should I invest’. I think the old abbagge applies – if you’re not looking after your investment then someone else is, and that can spelt trouble notwithstanding ones own ineptitude.

    I don’t believe 2 is correct – a caveat should read ‘in the current environment’ and a lot of people have had no experience in the taxes mentioned. NZ does have capital gains tax.

    Personally, I think managing a residential property is probably easier but I love commercial.

    Having said that, I may not have identified the target audience for this newsletter.

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